Budget 2026: When retirement becomes a tax trap – why India’s salary earners need urgent relief

India’s salaried class feels squeezed—not because they don’t want to pay taxes, but because the system increasingly treats retirement savings as a luxury. (AI image)

For a country that prides itself on a thriving middle class, India’s tax treatment of retirement savings has begun to feel oddly out of step with economic reality. Over the past few years, a series of amendments—presented as “rationalisations”—have quietly created a minefield for salaried employees who believed they were doing the right thing by saving for their future.Three provisions stand out for the burden they impose: taxation of employer contributions to provident and superannuation funds beyond ₹7.5 lakh; yearly taxation of accretions on such excess contributions; and taxation of interest earned on the employee’s own PF contributions above ₹2.5 lakh. In isolation each may appear technical. Together, they are reshaping retirement planning in ways that leave employees with little clarity, greater financial anxiety, and a rising tax bill on income they do not even receive today.A tax before the benefit arrivesThe first shock for employees came with the Finance Act, 2020, which capped employer contributions to recognised PF, approved superannuation funds and NPS at ₹7.5 lakh per year. Anything above that—common for senior professionals, mid-level employees in high-cost cities, and those in organisations with generous retirement policies—became taxable as a perquisite.But what stings more is that annual accretion—interest, dividend or similar growth—on this “excess contribution” is also taxed every single year. This is a tax on notional income, long before the employee sees a rupee of it.Many describe this as an upfront penalty on saving. Unlike bonuses or cash payments, retirement contributions are locked in for the long term. Yet tax is now collected today on money that may only be received decades later. That mismatch between tax incidence and actual receipt has become a major pain point.When exemption isn’t really exemptionThe hardship intensifies when the National Pension System comes into play. While the government justified taxing excess employer contributions by calling PF, superannuation and NPS an “EEE regime”, the law doesn’t fully support that claim.Under Section 10(12A), up to 60% of the NPS corpus can be withdrawn tax-free upon closure of the account or opting out of NPS. The remaining 40% must be used to purchase an annuity plan from a life insurance company, and the pension received from this annuity is fully taxable. Employees therefore argue that the premise of an entirely exempt regime is not accurate.Taxing the employee’s own PF savingsThe Finance Act, 2021 introduced another hit: PF interest earned on the employee’s own contribution beyond ₹2.5 lakh per year is taxable.For many mid-career employees, PF is the only disciplined savings instrument they rely on. A high PF contribution isn’t a luxury; it is a way to secure the future in the absence of universal social security.Yet the law now characterises high contributions—even when mandatory or part of salary structure—as an attempt to “enjoy full exemption”. The sting is sharper for those whose basic salary is high enough that the statutory 12% PF contribution itself may cross the ₹2.5 lakh threshold, triggering tax on interest even when the employee never intended to “over-contribute”. This change is seen as especially harsh in a country where inflation erodes purchasing power and pension adequacy is already a concern.“Also, these changes all appear to be part of the ultimate aim of the government to do away with all deductions and exemptions and make the ‘new tax regime’ the only regime available for all taxpayers,” says Ameet Patel, partner, Manohar Chowdhry & Associates.The bigger picture: When rules punish good behaviourAcross these provisions, a consistent theme emerges:India now taxes retirement savings more aggressively. Employees who save diligently, especially mid- to senior-level workers, face:

The result is that long-term savings face multiple tax points.Why reform is requiredThere is growing consensus across industry bodies that these provisions need urgent review. The argument is not about giving employees a windfall—it is about ensuring fairness and a safety net. With an ageing population, lack of a universal social security system applicable to all citizens, and rising cost of living, the existing provisions are detrimental . India’s salaried class feels squeezed—not because they don’t want to pay taxes, but because the system increasingly treats retirement savings as a luxury rather than a necessity. What was once a predictable, trusted savings pathway is now layered with caps, tax triggers, and compliance complications.“And this compounds the problems that the ageing population faces when insurance companies either refuse to issue new health policies to senior citizens or charge such high premia on the policies that having a Mediclaim policy becomes extremely expensive for such retired persons. As and when such a person needs large amounts to be paid to hospitals for medical treatments, the depleted savings are often inadequate and the entire family is put under huge financial stress,” concludes Patel.